Judging from the public commentary, last Friday’s US jobs report confused economists in terms of their understanding of economic developments in the world’s largest economy and the policy approach of the Federal Reserve. Virtually all the reactions have focused on “what” to think, but this episode also has important implications for “how” to think.
The surprise in Friday’s employment report is not to be underestimated. It extended well beyond a monthly job creation pace that, at 254,000 for September, was more than 100,000 above the consensus forecast and some 30,000 higher than the top estimate in Bloomberg’s survey of economist expectations. This unexpected turn of events came with upward revisions to the prior months’ numbers, sparking even more intrigue, as did other elements of the data release.
The consensus on the unemployment rate was for an unchanged reading of 4.2%, while the “whisper number” pointed to an increase to 4.3%. Instead, the unemployment rate fell to 4.1%. Indeed, only a slightly higher second decimal point stopped this headline-grabbing number from coming in at a rounded 4.0%. Meanwhile, hourly wage growth accelerated to 0.4% for the month, again better than the consensus forecast.
Taken at face value, this “blowout” report has four significant takeaways:
- The labor market, far from just being solid so late in an economic cycle and following the aggressive series of interest rate increases, has proven to be remarkably strong.
- The country is maintaining its “economic exceptionalism” at a time when the other two large economic regions with systemic global importance, China and Europe, continue to struggle.
- There is yet another good reason for the Fed to resist market pressure to be a single-mandate central bank that can act as if inflation is dead and focus only on the maximum-employment part of its dual mandate.
- There is a need for the market to be less aggressive in its pricing of the Fed’s 2024-2025 cycle of rate cuts.
Needless to say, there are several reasons to be cautious about making too much of these numbers. In addition to one-off effects and long-standing estimation challenges, this monthly data series is inherently noisy. Indeed, the same was said of the other data surprises last week, including numbers from the Jobs Openings and Labor Turnover Survey, which included a surprising increase in job vacancies.
Yet, tempting as it is, it is better to resist looking through the recent data. Instead, it’s important to think about the “how” behind the “what” — that is, look deeper into how the consensus on the US economy is formed, along with the policy views that accompany it.
Rather than being in a stable structural equilibrium, this is an economy that has experienced and continues to undergo major structural evolutions that have dulled the impact of the Fed’s previous interest rate increases and wrongfooted economists on numerous occasions. Indeed, recall the ping-pong shifts in the consensus view this year alone. It is a situation that is further complicated by the fact that the economy and markets continue to operate in what I think of as a “liquidity dominance” paradigm,
Going forward, we can expect the run of mixed data to continue, fueled by economic inflection points such as the changing importance of the various sectoral drivers of growth and disparities in household wealth, where the rich continue to thrive while the poor are under enormous pressure. This economy requires careful disaggregate analyses to accompany top-down assessments if economists are to avoid the surprises that fuel the confusing ping-pong narrative.
The “how” is also important, pertaining to three issues in particular.
First, central banks have long been the only policy game in town, creating a deep-rooted inclination to look past the impact of fiscal policy and the structural changes in systemically important segments of the private sector such as technology and services. This is a mistake because both these influences have meaningful impacts on economic outcomes.
Second, there is a temptation to think only in terms of a baseline scenario in a world that is normally distributed (that is, with a bell-shaped distribution of outcomes that has a dominant mean and very thin tails at either end of the distribution). This is unfortunate. We need to embrace a more multi-modal distribution with no dominant mean and relatively fat tails. My assessment of the distribution, which I have shared with you here and elsewhere for most of this year, is a recession (left tail) probability of 30%, a soft landing (belly of the curve) probability of 55%, and a favorable supply-shock scenario of a bigger-but-not-hotter economy (right tail) of 15%.
Finally, too many think of the Fed as remaining overly data-dependent and/or targeting a specific outcome. Instead, its policy approach seems to be evolving away from that phase of being excessively “data-dependent” and, therefore, essentially backward-looking, to adopting more of an insurance mindset that, rather than target a precise outcome, seeks more to reduce the probability of particularly damaging ones.
The Fed’s current risk-mitigation approach appears to be aimed at avoiding a new policy mistake by being too tight for too long, while downplaying the potential cost of the associated insurance. After all, why would the Fed have cut by 50 basis points last month when, according to Chair Jerome Powell, it assessed that the economy was “in a good place” and the central bank had “growing confidence that the strength in the labor market can be maintained.”
Last Friday’s data surprise relative to consensus expectations will not be the last one unless economists resist the temptation to look through the shock. What is needed in today’s economy is to be more open-minded about why such surprises keep occurring and how best to frame the accompanying policy regimes.
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